(Bloomberg) — Short sellers are now facing their biggest worry yet: the U.S. government. They are being trampled by the markets and attacked by angry executives.
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New allegations by federal authorities that one of the industry’s most prominent players, Andrew Left, committed securities fraud are sending shockwaves through an already shrinking field of investors who specialize in betting on specific stocks. For a group that has long courted controversy by taking on some of the biggest names in business, it’s a particularly sobering moment.
The U.S. government has been investigating the industry’s practices for years, but when the Justice Department and Securities and Exchange Commission investigations fizzled in recent months, many assumed the probes had failed. Even Left, who stepped down after investigators seized his computers and phones, returned to work.
That all changed on Friday.
Prosecutors announced criminal charges against him, while the SEC filed a civil lawsuit — cases that could bring down his company, Citron, and send him to prison for years.
According to the SEC, Left generated about $20 million in profits from illegal trading with nearly two dozen companies. Prosecutors accused him of repeatedly misleading the public — taking issue with what they called his “sensational” reports and describing times when he indicated he would leave bets running for much longer, even as he was already taking profits off the table.
At one point, Left boasted to colleagues that some of his public statements were causing retail investors to act the way he wanted and that it was like “taking candy from a baby,” the SEC said.
Other short sellers and their supporters were quick to argue Friday that the alleged misconduct was unique to the Left and should not be seen as a blanket condemnation of pessimistic investing.
Still, some said it could become harder for short sellers to find financial backers. Some predicted they would have to spend more on legal counsel and temper their public statements.
‘Faulty theory’
Left’s lawyer attacked the government’s case, saying it rested on a “flawed theory” that the investor had a duty to detail his trading plans, in addition to disclosing that he was active in the market. The lawyer warned that the charges would have a chilling effect on bearish research, and that it would harm public investors by allowing corporate misconduct to go undetected.
“The fact that Mr. Left trades in the securities he researches and writes about is well known to all, and there is no rule or law requiring a publisher who publicly discloses that he trades to also publish his private trading intentions,” the attorney, James Spertus, said in an emailed statement. “The charges filed today should concern all investors, as the publication of truthful information is critical to efficient markets.”
Short sellers have attracted a growing number of antagonists over the past decade. Executives at targeted companies convinced some shareholders that pessimistic investors were the real bad guys. Academics entered the conversation, with research showing that activists crossed the line with “smash and grab” tactics, knocking down stocks and then walking back their bets before the public could figure out who was right. Lawmakers held hearings on Capitol Hill.
The Justice Department’s indictment and the SEC’s complaint now provide fresh fodder for critics.
“Short sellers have benefited from regulators’ neglect for far too long, fearing they would discourage the occasional legitimate whistleblower,” said Paul Pelletier, a former federal prosecutor who represented a company targeted by a short seller.
The government’s cases seek to draw legal lines around what kind of statements amount to market manipulation in an era when small investors and hedge fund managers openly discuss their views on social media platforms and online message boards. The SEC noted that Left and Citron have a “substantial following” online, with more than 100,000 followers on Twitter alone. The problem, authorities said, was that Left used such platforms to mislead the public.
For example, the Justice Department accused him of announcing “extreme price targets” for some stocks he analyzed while concealing his intention to exit those positions long before the securities reached those levels.
“To profit from the intended price movement caused by Citron’s reports and tweets, Defendant Left covered all or substantially all of the positions he had in a targeted security, often within hours — and sometimes minutes — of publication,” the indictment said.
Left has been publishing reports and advocating bearish bets for more than 17 years. He made his name exposing accounting irregularities at Chinese companies that had flocked to the U.S. market. Prosecutors say he frequently commented on business news outlets including CNBC, Fox Business and Bloomberg Television.
He previously estimated that he had published about 200 reports over the years. More than a dozen of the companies he targeted later went private or declared bankruptcy. In a sign of the complicated relationship between shorts and regulators, U.S. authorities followed up on some of his investigations by filing civil and criminal charges against executives of companies he targeted.
Examples include Valeant Pharmaceuticals, which Left accused of being at the center of an illegal sales scheme. After then-U.S. Attorney Preet Bharara announced charges against two executives with ties to the company in 2016, he cited the role played by investor websites and news organizations.
Meager profits
Yet the business of short selling has only gotten trickier in recent years. Some bears struggled to bounce back from the long bull market that began after the 2008 financial crisis. Then came the rise of meme stock trading during the pandemic, with retail investors staging counter-raids on bets against GameStop and other struggling companies.
Short-selling profits can be small, even when a well-researched report rocks the market. Nate Anderson’s take on Adani Group last year wiped out as much as $153 billion in market value, but Anderson said in a statement this month that he made just over $4 million on the trade.
And even then, such meager gains can be wiped out as short sellers face the costs of lawsuits and now government investigations.
Jim Chanos, perhaps the best-known and longest-running short seller, turned his firm into a family office late last year after assets fell to less than $200 million.
“Investors — primarily institutional investors — have just given up on the idea that there’s going to be excess returns on the short side,” Chanos said of the decision to close. “People just didn’t want to invest.”
–With assistance from Stephanie Stoughton.
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